UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended December 31, 2002
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
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(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
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(State of Incorporation) (I.R.S. Employer
Identification No.)
680 Washington Boulevard
Stamford, Connecticut 06901
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(Address of principal executive offices) (Zip Code)
(203) 324-7635
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(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes X No
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
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Indicate the number of shares outstanding of each of the registrant's class of
common stock as of the latest practicable date:
12,706,162 shares of Common Stock, $0.01 par value as of January 30, 2003.
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MEMBERWORKS INCORPORATED
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of December 31, 2002
and June 30, 2002 2
Condensed Consolidated Statements of Operations for the three and six
months ended December 31, 2002 and 2001 3
Condensed Consolidated Statements of Cash Flows for the six
months ended December 31, 2002 and 2001 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Forward Looking Statements 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
Certifications 23
1
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
December 31, June 30,
2002 2002
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Assets (Unaudited)
Current assets:
Cash and cash equivalents $ 82,792 $ 51,185
Marketable securities - 912
Accounts receivable 11,857 9,831
Prepaid membership materials 3,230 2,061
Prepaid expenses 3,991 4,325
Membership solicitation and other deferred costs 108,229 129,085
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Total current assets 210,099 197,399
Fixed assets, net 28,235 31,420
Goodwill 42,039 42,039
Intangible assets, net 7,310 8,049
Other assets 2,333 1,910
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Total assets $ 290,016 $ 280,817
============== =============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 268 $ 1,070
Accounts payable 33,878 32,769
Accrued liabilities 64,212 57,709
Deferred membership fees 196,290 206,272
-------------- -------------
Total current liabilities 294,648 297,820
Deferred income taxes 2,863 -
Long-term liabilities 3,079 3,627
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Total liabilities 300,590 301,447
Shareholders' deficit:
Preferred stock, $0.01 par value -- 1,000 shares
authorized; no shares issued - -
Common stock, $0.01 par value -- 40,000 shares
authorized; 17,703 shares issued (17,493 shares
at June 30, 2002) 177 175
Capital in excess of par value 111,094 109,254
Accumulated deficit (19,024) (42,185)
Accumulated other comprehensive loss (453) (373)
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Total shareholders' equity before treasury stock 91,794 66,871
Treasury stock, 5,008 shares at cost (4,139 shares at June 30, 2002) (102,368) (87,501)
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Total shareholders' deficit (10,574) (20,630)
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Total liabilities and shareholders' deficit $ 290,016 $ 280,817
============== =============
The accompanying notes are an integral part of
these consolidated financial statements.
2
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Three months ended Six months ended
December 31, December 31,
------------------------ ------------------------
2002 2001 2002 2001
----------- ----------- ----------- ----------
Revenues $ 114,045 $ 102,684 $ 219,049 $ 221,648
Expenses:
Operating 19,178 19,508 37,252 40,576
Marketing 69,899 57,444 135,448 134,234
General and administrative 18,764 18,570 37,627 41,579
Restructuring and other charges - 6,893 - 6,893
Amortization of intangible assets 346 440 739 1,115
----------- ----------- ----------- ----------
Operating income (loss) 5,858 (171) 7,983 (2,749)
Settlement of investment related litigation (Note 4) - - 19,148 -
(Loss) gain on sale of subsidiary (Note 3) - - (959) 65,608
Net loss on investment (Note 3) - (9,043) (206) (31,339)
Other income (expense), net 221 54 340 (36)
----------- ----------- ----------- ----------
Income (loss) before minority interest 6,079 (9,160) 26,306 31,484
Minority interest - - - 450
----------- ----------- ----------- ----------
Income (loss) before income taxes 6,079 (9,160) 26,306 31,934
Provision for income taxes (729) - (3,143) (743)
----------- ----------- ----------- ----------
Income (loss) before cumulative effect of accounting change 5,350 (9,160) 23,163 31,191
Cumulative effect of accounting change (Note 2) - - - (5,907)
----------- ----------- ----------- ----------
Net income (loss) $ 5,350 $ (9,160)$ 23,163 $ 25,284
=========== =========== =========== ==========
Basic earnings (loss) per share:
Income (loss) before cumulative effect of accounting change $ 0.42 $ (0.62)$ 1.79 $ 2.07
Cumulative effect of accounting change - - - (0.39)
----------- ----------- ----------- ----------
Basic earnings (loss) per share $ 0.42 $ (0.62)$ 1.79 $ 1.68
=========== =========== =========== ==========
Diluted earnings (loss) per share:
Income (loss) before cumulative effect of accounting change $ 0.40 $ (0.62)$ 1.71 $ 2.01
Cumulative effect of accounting change - - - (0.38)
----------- ---------- ----------- -----------
Diluted earnings (loss) per share $ 0.40 $ (0.62)$ 1.71 $ 1.63
=========== =========== =========== ==========
Weighted average common shares used in earnings (loss) per
share calculations:
Basic 12,735 14,789 12,949 15,084
========== =========== =========== ===========
Diluted 13,396 14,789 13,530 15,505
=========== =========== =========== ==========
The accompanying notes are an integral part of
these consolidated financial statements.
3
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
For the six months ended
December 31,
---------------------------------
2002 2001
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Operating activities
Net income $ 23,163 $ 25,284
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Revenues before deferral 209,140 206,697
Marketing costs before deferral (114,673) (125,446)
Revenues recognized (219,049) (221,648)
Marketing costs expensed 135,448 134,234
Depreciation and amortization 6,169 6,677
Deferred income taxes 2,864 -
Gain on settlement (19,148) -
Net loss (gain) on sale of subsidiary 959 (65,608)
Net loss on investment 206 31,339
Restructuring and other charges - 1,585
Minority interest - (450)
Cumulative effect of accounting change - 5,907
Other 382 688
Change in assets and liabilities:
Accounts receivable (1,529) 6,358
Prepaid membership materials (1,169) (1,173)
Prepaid expenses 334 (2,087)
Other assets (424) 32
Related party payables - 12
Accounts payable 1,044 (6,241)
Accrued liabilities 6,319 455
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Net cash provided by (used in) operating activities 30,036 (3,385)
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Investing activities
Acquisition of fixed assets (2,762) (2,999)
Settlement of investment related litigation 19,148 -
(Purchase price adjustments) proceeds from sale of subsidiary, net of
cash sold (750) 45,997
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Net cash provided by investing activities 15,636 42,998
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Financing activities
Net proceeds from issuance of stock and warrants 1,851 1,196
Treasury stock purchases (14,957) (15,665)
Payments of long-term obligations (927) (359)
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Net cash used in financing activities (14,033) (14,828)
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Effect of exchange rate changes on cash and cash equivalents (32) (221)
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Net increase in cash and cash equivalents 31,607 24,564
Cash and cash equivalents at beginning of period 51,185 22,736
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Cash and cash equivalents at end of period $ 82,792 $ 47,300
============== =============
The accompanying notes are an integral part of these
consolidated financial statements.
4
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information. Accordingly, such
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included. The
preparation of these consolidated financial statements in conformity with
generally accepted accounting principles requires management of the Company to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. Operating results for the three and six months ended December 31,
2002 are not necessarily indicative of the results that may be expected for the
fiscal year ending June 30, 2003. For further information, refer to the
financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K with respect to the fiscal year ended June 30, 2002.
NOTE 2 - CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Adoption of SFAS 142
Memberworks Incorporated ("the Company" or "MemberWorks") adopted Financial
Accounting Standards Board Statement ("SFAS") No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), effective July 1, 2001. With the adoption of
SFAS 142, the Company reassessed the estimated useful lives and residual values
of all acquired intangible assets to make any necessary amortization period
adjustments. Based on that assessment, only goodwill was determined to have an
indefinite useful life and no adjustments were made to the amortization periods
or residual values of other intangible assets. The Company determined that at
July 1, 2001, there was an impairment of goodwill of $5,907,000 at one of its
reporting units due to the change in methodology of calculating impairment under
SFAS 142 concurrent with downward trends in the operations of the reporting
unit. This amount was recorded as a cumulative effect of accounting change in
the statement of operations for the quarter ended September 30, 2001.
NOTE 3 - GAIN ON SALE OF SUBSIDIARY/LOSS ON INVESTMENT
During the quarter ended September 30, 2001, the Company sold its investment in
iPlace, Inc. for $50,111,000 in cash and 1,601,000 shares of Homestore.com, Inc.
stock. The Company reported a gain of $65,608,000 on the sale. During the
quarter ended September 30, 2002, the Company settled with Homestore.com, Inc.
all issues pending related to amounts held in escrow in connection with the
sale. The Company recorded a net loss of $959,000 related to this purchase price
adjustment in the quarter ended September 30, 2002.
During fiscal 2002, the investment in Homestore.com, Inc. declined in value and
management determined that the decline was other than temporary. As a result,
the Company wrote down its investment in Homestore.com, Inc. to its fair value
and recognized a loss of $22,296,000 in the quarter ended September 30, 2001 and
a loss of $9,043,000 in the quarter ended December 31, 2001.
In addition, the Company sold all of its Homestore.com, Inc. common stock during
the quarter ended September 30, 2002. The Company recognized a loss of $206,000
in connection with this sale.
NOTE 4 - Settlement of investment related litigation
During the quarter ended September 30, 2002, MemberWorks, along with certain of
the other former shareholders of iPlace, Inc., settled their lawsuit against
Homestore.com, Inc. The total settlement amount in favor of the plaintiffs was
$23,000,000 of which MemberWorks received $19,148,000.
5
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 5 - INCOME TAX EXPENSE
Income tax expense as a percentage of pre-tax income was approximately 12% for
the three and six months ended December 31, 2002. The effective tax rate varied
from the U.S. statutory rate for the three and six months ended December 31,
2002 primarily due to the utilization of net operating loss carryforwards.
During the quarter ended September 30, 2001, the Company recorded a provision
for alternative minimum taxes of approximately $742,000 in connection with the
gain on the sale of iPlace, Inc. This provision for alternative minimum taxes
was later reversed in the June 2002 quarter due to a change in the tax laws.
NOTE 6 - EARNINGS PER SHARE
Basic and diluted earnings per share amounts are determined in accordance with
the provisions of SFAS No. 128, "Earnings Per Share." The following table sets
forth the reconciliation of the numerators and denominators in the computation
of basic and diluted earnings per share (in thousands, except per share data):
Three Months Ended Six Months Ended
December 31, December 31,
----------------------- ------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Numerator for basic and diluted earnings (loss) per share:
Net income (loss) before cumulative effect of accounting change $ 5,350 $ (9,160) $ 23,163 $ 31,191
Cumulative effect of accounting change - - - (5,907)
---------- ---------- ---------- ----------
Net income (loss) $ 5,350 $ (9,160) $ 23,163 $ 25,284
========== ========== ========== ==========
Denominator for basic earnings (loss) per share:
Weighted average number of common shares outstanding - basic 12,735 14,789 12,949 15,084
Effect of dilutive securities:
Options 661 - 581 421
---------- ---------- ---------- ----------
Weighted average number of common shares outstanding - diluted 13,396 14,789 13,530 15,505
========== ========== ========== ==========
Basic earnings (loss) per share $ 0.42 $ (0.62) $ 1.79 $ 1.68
========== ========== ========== ==========
Diluted earnings (loss) per share $ 0.40 $ (0.62) $ 1.71 $ 1.63
========== ========== ========== ==========
The diluted earnings (loss) per share calculation excludes the effect of
potentially dilutive shares when their effect is antidilutive. For the three
months ended December 31, 2002 and 2001, the Company had 3,041,000 and 4,553,000
shares, respectively, of potentially dilutive stock options outstanding that are
not included in the calculation as they are antidilutive. For the six months
ended December 31, 2002 and 2001, the Company had 3,112,000 and 3,479,000
shares, respectively, of potentially dilutive stock options that are not
included in the calculations as they are antidilutive.
6
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 7 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
Three months ended Six months ended
December 31, December 31,
-------------------------- --------------------------
2002 2001 2002 2001
------------ ------------- ------------- ------------
Net income (loss) $ 5,350 $ (9,160) $ 23,163 $ 25,284
Foreign currency translation gain (loss) 5 (87) (80) (251)
------------ ------------- ------------- ------------
Comprehensive income (loss) $ 5,355 $ (9,247) $ 23,083 $ 25,033
============ ============= ============= ============
NOTE 8 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows (in thousands):
As of December 31, 2002 As of June 30, 2002
----------------------------------- ------------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
----------------- ----------------- ------------------ -----------------
Amortized intangible assets:
Membership and Client Relationships $ 13,195 $ (6,141) $ 13,195 $ (5,466)
Other 950 (694) 950 (630)
----------------- ----------------- ------------------ -----------------
Total amortized intangible assets $ 14,145 $ (6,835) $ 14,145 $ (6,096)
================= ================= ================== =================
Unamortized intangible assets:
Goodwill $ 42,039 $ 42,039
The future intangible amortization expense for the next five years is estimated
to be as follows (in thousands):
Fiscal Year:
2003 $ 1,393
2004 1,045
2005 840
2006 695
2007 554
Goodwill was tested for impairment during the quarter ended September 30, 2002
as required by SFAS 142. The Company has concluded that none of its goodwill is
impaired. Fair value was estimated using discounted cash flow methodologies. In
addition, the Company reassessed the estimated useful lives of its indefinite
intangible assets and determined that the lives were appropriate. The Company
will test the goodwill of each of its reporting units annually or more
frequently if impairment indicators exist.
NOTE 9 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying condensed consolidated balance
sheets as of December 31, 2002 and June 30, 2002 include an allowance for
membership cancellations of $26,328,000 and $23,753,000, respectively.
7
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 10 - RESTRUCTURING CHARGES
On October 11, 2001, the Company announced the implementation of several cost
saving initiatives due to a slowdown in consumer response rates and increased
economic uncertainty in both the U.S. and abroad. This restructuring program
included a workforce reduction, the closing of the Company's United Kingdom
operations and the downsizing of the operational infrastructure throughout the
Company. As a result of the restructuring program, the Company recorded
restructuring charges of $6,893,000 during the quarter ended December 31, 2001.
The major components of the restructuring charges and the remaining accrual
balances as of December 31, 2002 are as follows (in thousands):
Total Non-cash Cash Charges Liability
Charges Charges to date to date Balance
-------------- ----------------- --------------- --------------
Workforce reduction $ 2,214 $ - $ 2,053 $ 161
Lease obligations 3,094 - 1,343 1,751
Asset disposals 1,585 1,585 - -
-------------- ----------------- --------------- --------------
Total $ 6,893 $ 1,585 $ 3,396 $ 1,912
============== ================= =============== ==============
NOTE 11 - LEGAL PROCEEDINGS
Except as set forth below, in management's opinion, there are no significant
legal proceedings to which the Company or any of its subsidiaries is a party or
to which any of their properties are subject. The Company is involved in other
lawsuits and claims generally incidental to its business including, but not
limited to, various suits, including previously disclosed suits in the 2002
Annual Report filed on Form 10-K, brought against the Company by individual
consumers seeking monetary and/or injunctive relief relating to the marketing of
the Company's programs. In addition, from time to time, and in the regular
course of its business, the Company receives inquiries from various federal
and/or state regulatory authorities. Management does not believe that there will
be any material effect on the results of operations as a result of its
outstanding litigation proceedings.
In March 2002, the Company and other plaintiffs filed suit against
Homestore.com, Inc. in United States District Court for the District of
Connecticut. The action was transferred to the United States District Court for
the Central District of California. The suit, which sought injunctive and other
relief, alleged securities fraud, negligent misrepresentation, breach of
contract and other grounds in connection with the Company's sale of its interest
in iPlace, Inc. In response to plaintiffs' preliminary motions, the court
ordered Homestore.com, Inc. to place $58,000,000 in a constructive trust pending
resolution of the lawsuit or further order of the court. During the quarter
ended September 30, 2002, MemberWorks, along with certain of the other former
shareholders of iPlace, Inc., settled their lawsuit against Homestore.com, Inc.
The total settlement amount in favor of the plaintiffs was $23,000,000, of which
MemberWorks received $19,148,000.
8
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
On January 24, 2003, the Company filed a motion with the Superior Court for the
Judicial District of Hartford, Connecticut to vacate and oppose the confirmation
of an arbitration award issued in December 2002. The arbitration, filed against
the Company by MedValUSA Health Programs, Inc. ("MedVal") in September 2000,
involved claims of breach of contract, breach of the duty of good faith and fair
dealing, and violation of the Connecticut Unfair Trade Practices Act ("CUTPA").
Even though the arbitrators found that MemberWorks was not liable to MedVal for
any compensatory damages, they awarded $5,495,000 in punitive damages and costs
against MemberWorks solely under CUTPA. MemberWorks believes that this
arbitration award is unjustified and not based on any existing legal precedent.
Specifically, the Company is challenging the award on a number of grounds,
including that it violates a well defined public policy against excessive
punitive damage awards, raises constitutional issues and disregards certain
legal requirements for a valid award under CUTPA. The hearing on the Company's
motion was held on February 10, 2003. However, the date that the judge will rule
on the motion is unknown. While the Company intends to vigorously seek to vacate
this award, as well as to take action to prevent the enforcement of the award
by, among other things, seeking to prevent the confirmation of the award, there
can be no assurance that MemberWorks will be successful in its efforts. The
Company has made no provision in its financial statements for this contingency
because it believes that a loss is not probable.
NOTE 12 - NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"), which is effective for exit or disposal activities that are initiated
after December 31, 2002. SFAS 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan and nullifies Emerging
Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including Certain
Costs in a Restructuring)." MemberWorks does not believe that the adoption of
SFAS 146 will have a material impact on the Company's financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires a guarantor to include
disclosure of certain obligations, and if applicable, at the inception of the
guarantee, recognize a liability for the fair value of other certain obligations
undertaken in issuing a guarantee. The recognition requirement is effective for
guarantees issued or modified after December 31, 2002. MemberWorks does not
believe that the adoption of FIN 45 will have a material impact on the Company's
financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123." This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, this Statement amends APB Opinion No. 28,
"Interim Financial Reporting," to require disclosure about those effects in
interim financial information. The transition provisions of this statement shall
be effective for financial statements with fiscal years ending after December
15, 2002. The disclosure provisions of this statement shall be effective for
financial reports containing condensed financial statements for interim periods
beginning after December 15, 2002. The Company has not yet completed its
analysis of the effects of adopting this statement on its consolidated financial
positions or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51 and applies immediately to any variable
interest entities created after January 31, 2003 and to variable interest
entities in which an interest is obtained after that date. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN 46
must be applied for the first interim or annual period beginning after June 15,
2003. While it will continue to evaluate the requirements of FIN 46, MemberWorks
does not believe that the adoption of FIN 46 will have a material impact on the
Company's financial statements.
9
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
MemberWorks addresses the needs of organizations seeking to leverage the
expertise of an outside provider in offering membership service programs.
Membership service programs offer selected products and services from a variety
of vendors for an annual fee or a monthly fee. Membership service programs
intend to enhance existing relationships between businesses and consumers.
MemberWorks derives its revenues principally from annually renewable membership
fees. The Company generally receives full payment of annual fees at or near the
beginning of the membership period, but recognizes revenue as the member's
refund privilege expires. Similarly, the costs associated with soliciting each
new member, as well as the cost of royalties paid to clients, are recognized as
the related revenue is recognized. Profitability and cash flow generated from
renewal memberships exceed that of new memberships due to the absence of
solicitation costs associated with new member procurement.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that are important to the
Company's financial condition and results and involve subjective or complex
judgments on the part of management, often as a result of the need to make
estimates. The following areas all require the use of judgments and estimates:
membership cancellation rates, deferred marketing costs, valuation of intangible
assets, estimation of remaining useful lives of intangible assets, estimation of
the effective tax rate and valuation of deferred tax assets. Estimates in each
of these areas are based on historical experience and various assumptions that
MemberWorks believes are appropriate. Actual results may differ from these
estimates. MemberWorks believes the following represent the critical accounting
policies of the Company as contemplated by Financial Reporting Release No. 60,
"Cautionary Advice Regarding Disclosure about Critical Accounting Policies." For
a summary of all of the Company's significant accounting policies, see Note 2 of
the Notes to the consolidated financial statements of the Company's 2002 Annual
Report filed on Form 10-K.
Revenue recognition
Membership fees are billed through clients of the Company primarily through
credit cards. During an initial annual membership term or renewal term, a member
may cancel his or her membership in the program, either for a complete refund of
the membership fee for that period or a prorata refund based on the remaining
portion of the membership period depending upon the terms of the membership
program. Deferred membership fees are recorded, net of estimated cancellations,
after the trial period has expired, and are amortized as revenues from
membership fees upon the expiration of membership refund privileges. Revenue
from members who are charged on a monthly payment program is recognized, net of
estimated cancellations, as the membership fees are billed. An allowance for
cancellations is established based on management's estimates and is updated
regularly. In determining the estimate of allowance for cancellations,
management analyzes historical cancellation experience, current economic trends
and changes in customer demand for the Company's products. Actual membership
cancellations are charged against the allowance for cancellations on a current
basis. If actual cancellations differ from the estimate, the results of
operations would be impacted. Accrued liabilities set forth in the accompanying
consolidated balance sheets as of December 31, 2002 and June 30, 2002 include an
allowance for membership cancellations of $26.3 million and $23.8 million,
respectively.
Membership solicitation and other deferred costs
Membership solicitation costs include marketing and direct mail costs related
directly to membership solicitation (i.e., direct response advertising costs).
In accordance with the American Institute of Certified Public Accountants
Statement of Position 93-7, "Reporting on Advertising Costs," direct response
advertising costs are deferred and charged to operations over the membership
period. Other deferred costs consist of royalties paid to clients, which relate
to the same revenue streams as the direct response advertising costs and are
also charged to income over the membership period. Total membership solicitation
costs incurred to obtain a new member generally are less than the estimated
total membership fees. However, if total membership solicitation costs were to
exceed total estimated membership fees, an adjustment would be made to the
extent of any impairment.
10
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Valuation of goodwill and other intangibles
MemberWorks reviews the carrying value of its goodwill and other intangible
assets, and assesses the remaining estimated useful lives of its intangible
assets, in accordance with Financial Accounting Standards Board ("FASB")
Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). The
Company reviews the carrying value of its goodwill and other intangible assets
by comparing such amounts to their fair values. MemberWorks is required to
perform this comparison at least annually or more frequently if circumstances
indicate possible impairment. When determining fair value, the Company utilizes
various assumptions, including projections of future cash flows. A change in
these underlying assumptions will cause a change in the results of the tests
and, as such, could cause fair value to be less than the carrying amounts. In
such an event, MemberWorks would then be required to record a corresponding
charge, which would negatively impact earnings. Goodwill at July 1, 2002 and
2001, was tested for impairment during the quarters ended September 30, 2002 and
2001, respectively. The Company concluded that none of its goodwill was impaired
as of July 1, 2002. As of July 1, 2001, the Company determined that there was an
impairment of goodwill of $5.9 million at one of its reporting units due to the
change in methodology of calculating impairment under SFAS 142 concurrent with
downward trends in the operations of the reporting unit (see Note 2 to the
Condensed Consolidated Financial Statements). This amount was recorded as a
cumulative effect of accounting change in the statement of operations in the
fiscal quarter ended September 30, 2001.
Income tax provision
MemberWorks estimates current tax provisions or benefits based on a projected
effective tax rate for the fiscal year ended June 30, 2003 using the most
currently available information and forecasts. The projected effective tax rate
is updated for actual results and estimates when they become known. In addition,
MemberWorks assesses the realization of deferred tax assets considering various
assumptions, including estimates of future taxable income and ongoing tax
strategies. A change in these underlying assumptions would impact the results of
operations.
THREE MONTHS ENDED DECEMBER 31, 2002 VS. THREE MONTHS ENDED DECEMBER 31, 2001
REVENUES. Revenues increased 11% to $114.0 million for the quarter ended
December 31, 2002 from $102.7 million for the quarter ended December 31, 2001.
The increase in revenues is due to the Company's strategic initiative to migrate
its members that participate in a full-money-back refund policy program to a
prorata refund policy program, in addition to an increase in the average program
price point. As of December 31, 2002, virtually all of the Company's membership
base is enrolled in a prorata refund policy program. As a result of the
Company's strategic initiative to move its members to a prorata refund policy
program, revenues which would have been recognized at the end of a membership
year are now recognized ratably during the membership year as the refund
privileges expire in accordance with Staff Accounting Bulleting 101, "Revenue
Recognition in the Financial Statements" ("SAB 101"). As a percentage of total
revenues, annual renewal revenues were 50% in 2002 and 50% in 2001. Revenue from
members who are charged on a monthly payment program increased to $17.4 million
for the quarter ended December 31, 2002 from $7.8 million for the quarter ended
December 31, 2001 due to an increase in members enrolled in a monthly payment
plan.
11
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
REVENUES BEFORE DEFERRAL. Revenues before deferral, which are revenues before
the application of SAB 101, are an important measure of the Company's
performance during the reporting period because they represent the actual
membership fees billed during the current reporting period less an allowance for
cancellations. The Company's management utilizes revenues before deferral to
measure the Company's current performance. In contrast, revenue, as recognized
under SAB 101, represents the membership fees billed in prior periods less an
allowance for cancellations that have been amortized and recognized as the
refund privileges expire. Revenues before deferral increased 10% to $111.0
million for the quarter ended December 31, 2002 from $101.2 million for the
quarter ended December 31, 2001. Revenues before deferral increased compared to
the prior year primarily due to an increase in the average program price point.
The Company's membership base decreased to approximately 6.3 million members at
December 31, 2002 from 6.5 million members at December 31, 2001 due to the
controlled marketing slow down implemented in the beginning of fiscal 2002. This
controlled marketing slow down was due to decreased response rates in certain
distribution channels. As a percentage of total revenues before deferral, annual
renewal revenues were 49% in 2002 and 50% in 2001. Members who are billed on a
monthly payment plan are billed each month until the member cancels and the
revenues from these members are excluded from the calculation of annual renewal
revenues. Revenue from members who are charged on a monthly payment program
increased to $17.4 million for the quarter ended December 31, 2002 from $7.8
million for the quarter ended December 31, 2001 due to an increase in members
enrolled in a monthly payment plan.
OPERATING EXPENSES. Operating expenses consist of member service call center
costs, membership benefit costs and membership program fulfillment costs.
Operating expenses decreased 2% to $19.2 million for the quarter ended December
31, 2002 from $19.5 million for the quarter ended December 31, 2001. As a
percentage of revenues, operating expenses decreased to 16.8% for the quarter
ended December 31, 2002 from 19.0% for the quarter ended December 31, 2001 due
to cost control measures and operating expense leverage gained from increased
revenues.
MARKETING EXPENSES. Marketing expenses consist of direct solicitation costs
incurred to obtain new members and royalties paid to clients, which are
generally amortized in the same manner as the related revenue. Marketing
expenses increased 22% to $69.9 million for the quarter ended December 31, 2002
from $57.4 million for the quarter ended December 31, 2001 due to an increased
mix of non-deferred marketing costs expensed in 2002. As a percentage of
revenue, marketing expenses increased to 61.3% in 2002 from 55.9% in 2001.
MARKETING COSTS BEFORE DEFERRAL. Marketing costs before deferral, which are
marketing costs before the application of SAB 101, are an important measure of
the Company's performance during the reporting period because they represent the
actual marketing costs incurred during the current reporting period. The
Company's management utilizes marketing costs before deferral to measure the
Company's current performance. In contrast, marketing expenses, as recognized
under SAB 101, represent the marketing costs incurred in prior periods that have
been amortized and recognized in the same manner as the related revenues.
Marketing costs before deferral increased 9% to $59.8 million for the quarter
ended December 31, 2002 from $55.1 million for the quarter ended December 31,
2001 primarily due to the 10% increase in revenue before deferral. As a
percentage of revenues before deferral, marketing costs before deferral
decreased to 53.8% in 2002 from 54.4% in 2001 primarily due to an improvement in
new member marketing efficiencies.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily include personnel-related costs, occupancy costs and other overhead
costs. General and administrative expenses increased 1% to $18.8 million for the
quarter ended December 31, 2002 from $18.6 million for the quarter ended
December 31, 2001. As a percentage of revenues, general and administrative
expenses decreased to 16.5% in 2002 from 18.1% in 2001 primarily due to leverage
gained from increased revenues.
AMORTIZATION OF OTHER INTANGIBLES. Intangible amortization decreased to $0.3
million during the quarter ended December 31, 2002 from $0.4 million for the
quarter ended December 31, 2001.
12
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OTHER INCOME, NET. Other income, net is primarily composed of interest income
from cash and cash equivalents and interest expense on the Company's borrowings
under its line of credit during the period. Other income was $0.2 million for
the quarter ended December 31, 2002 versus $0.1 million for the quarter ended
December 31, 2001. The increase in other income is due to an increased cash
balance during the December 31, 2002 quarter.
PROVISION FOR INCOME TAXES. During the quarter ended December 31, 2002, the
Company recorded a tax provision of $0.7 million based on an effective tax rate
of approximately 12%. The effective tax rate varied from the U.S. statutory rate
for the quarter ended December 31, 2002 primarily due to the utilization of net
operating loss carryforwards. The Company was not required to record a provision
for income taxes for the quarter ended December 31, 2001 due to a tax loss
realized in that period.
SIX MONTHS ENDED DECEMBER 31, 2002 VS. SIX MONTHS ENDED DECEMBER 31, 2001
REVENUES. Revenues decreased 1% to $219.0 million for the six months ended
December 31, 2002 from $221.6 million for the six months ended December 31,
2001. The decrease in revenues is due to the sale of iPlace, Inc. and the
closing of the United Kingdom operations. Excluding iPlace, Inc. from the prior
year, revenues were $219.0 million and $212.3 million during the six months
ended December 31, 2002 and 2001, respectively. The increase in revenues is due
to the Company's strategic initiative to migrate its members that participate in
a full-money-back refund policy program to a prorata refund policy program, in
addition to an increase in the average program price point. As of December 31,
2002, virtually all of the Company's membership base is enrolled in a prorata
refund policy program. As a result of the Company's strategic initiative to move
its members to a prorata refund policy program, revenues which were recognized
at the end of a membership year are now recognized ratably during the membership
year as the refund privileges expire in accordance with SAB 101. As a percentage
of total revenues, annual renewal revenues were 48% in 2002 and 49% in 2001.
Members who are billed on a monthly payment plan are billed each month until the
member cancels and the revenues from these members are excluded from the
calculation of annual renewal revenues. The decrease in annual renewal revenues
as a percentage of total revenues is due to the increase in revenue from monthly
members. Revenue from members who are charged on a monthly payment program
increased to $33.8 million during the six months ended December 31, 2002 from
$15.5 million during the six months ended December 31, 2001 due to an increase
in members enrolled in a monthly payment plan.
REVENUES BEFORE DEFERRAL. Revenues before deferral increased 1% to $209.1
million for the six months ended December 31, 2002 from $206.7 million for the
six months ended December 31, 2001. Excluding revenue from iPlace, Inc. and the
United Kingdom from the prior year, revenue before deferral increased 8%.
Revenues before deferral increased compared to the prior year due to an increase
in the average program price points as more members move to the premium
products. The Company's membership base decreased to approximately 6.3 million
members at December 31, 2002 from 6.5 million members at December 31, 2001 due
to the controlled marketing slow down implemented in the beginning of fiscal
2002. As a percentage of total revenues before deferral, annual renewal revenues
were 49% in 2002 and 49% in 2001. Revenue from members who are charged on a
monthly payment program increased to $33.8 million during the six months ended
December 31, 2002 from $15.5 million during the six months ended December 31,
2001 due to an increase in members enrolled in a monthly payment plan.
13
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OPERATING EXPENSES. Operating expenses decreased 8% to $37.3 million for the six
months ended December 31, 2002 from $40.6 million for the six months ended
December 31, 2001 primarily due to sale of iPlace, Inc. As a percentage of
revenues, operating expenses decreased to 17.0% for the six months ended
December 31, 2002 from 18.3% for the six months ended December 31, 2001
primarily due to the sale of iPlace, Inc. which had higher operating costs as a
percentage of revenue, the cost savings initiatives implemented in the beginning
of the December 2001 quarter and operating expense leverage gained from
increased revenues.
MARKETING EXPENSES. Marketing expenses increased 1% to $135.4 million for the
six months ended December 31, 2002 from $134.2 million for the six months ended
December 31, 2001. As a percentage of revenue, marketing expenses increased to
61.8% in 2002 from 60.6% in 2001. These increases are primarily due to a higher
level of non-deferrable marketing expenses in six months ended December 31,
2002.
MARKETING COSTS BEFORE DEFERRAL. Marketing costs before deferral decreased 9% to
$114.7 million for the six months ended December 31, 2002 from $125.4 million
for the six months ended December 31, 2001. As a percentage of revenues before
deferral, marketing costs before deferral decreased to 54.8% in 2002 from 60.7%
in 2001. These decreases were primarily due to an improvement in new member
marketing efficiencies and the sale of iPlace, Inc.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased 10% to $37.6 million for the six months ended December 31, 2002 from
$41.6 million for the six months ended December 31, 2001. As a percentage of
revenues, general and administrative expenses decreased to 17.2% in 2002 and
18.8% in 2001. These decreases were primarily due to the sale of iPlace, Inc.,
the closing of the United Kingdom operations and cost savings initiatives
implemented in the beginning of the quarter ended December 31, 2001.
AMORTIZATION OF OTHER INTANGIBLES. Intangible amortization decreased to $0.7
million during the six months ended December 31, 2002 from $1.1 million for the
six months ended December 31, 2001 due to the effect of the sale of iPlace, Inc.
SETTLEMENT OF INVESTMENT RELATED LITIGATION. During the quarter ended September
30, 2002, MemberWorks, along with certain of the other former shareholders of
iPlace, Inc., settled their lawsuit against Homestore.com, Inc. The total
settlement amount in favor of the plaintiffs was $23.0 million of which
MemberWorks received $19.1 million.
GAIN ON SALE OF SUBSIDIARY. During the quarter ended September 30, 2001, the
Company sold its investment in iPlace, Inc. for $50.1 million in cash and 1.6
million shares of Homestore.com, Inc. stock. The Company reported a gain of
$65.6 million on the sale. During the quarter ended September 30, 2002, the
Company settled with Homestore.com, Inc. all issues pending related to amounts
held in escrow in connection with the sale. The Company recorded a net loss of
$1.0 million related to this purchase price adjustment in the quarter ended
September 30, 2002.
NET LOSS ON INVESTMENT. During the quarter ended September 30, 2001, the Company
reported a loss of $22.3 million reflecting the write-down of the Company's
investment in Homestore.com, Inc. common stock to its fair market value. During
the quarter ended September 30, 2002, the Company sold all of its Homestore.com,
Inc. common stock and recognized a loss of $0.2 million.
OTHER INCOME/EXPENSE, NET. Other income/expense, net is primarily composed of
interest income from cash and cash equivalents and interest expense on the
Company's borrowings under its line of credit. Other income increased to $0.3
million in 2002 from expense of less than $0.1 million in 2001 due to the
increase in the Company's cash balance.
14
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
PROVISION FOR INCOME TAXES. During the six months ended December 31, 2002, the
Company recorded a tax provision of $3.1 million based on an effective tax rate
of approximately 12%. The effective tax rate varied from the U.S. statutory rate
for the six months ended December 31, 2002 primarily due to the utilization of
net operating loss carryforwards. During the quarter ended September 30, 2001,
the Company recorded a provision for alternative minimum taxes of approximately
$0.7 million in connection with the gain on the sale of iPlace, Inc. this
provision for alternative minimum taxes was later reversed in the June 2002
quarter due to a change in the tax laws.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $30.0 million for the six months
ended December 31, 2002 versus cash used in operating activities of $3.4 million
for the six months ended December 31, 2001. Net cash provided by operating
activities is comprised of operating cash flow before changes in assets and
liabilities and changes in assets and liabilities.
Operating cash flow before changes in assets and liabilities was positive $25.5
million for the six months ended December 31, 2002 compared to negative $0.7
million for the six months ended December 31, 2001. The increase in operating
cash flow before changes in assets and liabilities was due to a decrease in
marketing costs before deferral as a percentage of revenue before deferral, cost
savings as a result of the restructuring plan and the actual costs incurred in
December 2001 related to the restructuring plan. Revenues before deferral were
$209.1 million for the six months ended December 31, 2002 versus $206.7 million
for the six months ended December 31, 2001. Marketing expenses before deferral
were $114.7 million for the six months ended December 31, 2002 versus $125.4
million for the six months ended December 31, 2001. As a percent of revenues
before deferral, marketing expenses before deferral were 54.8% in 2002 and 60.7%
in 2001. These decreases were primarily due to an improvement in new member
marketing efficiencies and the sale of iPlace, Inc. Revenues before deferral
increased 8% excluding revenue from iPlace, Inc., which was sold in August 2001,
and the United Kingdom operating subsidiary, which was closed in October 2001,
from the prior year. Excluding marketing expenses from iPlace, Inc., marketing
expenses before deferral decreased 4%.
Changes in assets and liabilities increased cash from operating activities by
$4.6 million in 2002 versus a decrease of $2.6 million in 2001. The positive
effect of changes in assets and liabilities during the six months ended December
31, 2002 was primarily due to an increase in the cancellation liability related
to the increase in revenue before deferral and the timing of the payment of
certain expenses which the Company expects will reverse in the March 2003
quarter.
Net cash provided by investing activities was $15.6 million in 2002 versus $43.0
million in 2001. During the six months ended December 31, 2002, MemberWorks,
along with certain of the other former shareholders of iPlace, Inc., settled
their lawsuit against Homestore.com, Inc. The total settlement amount in favor
of the plaintiffs was $23.0 million of which MemberWorks received $19.1 million.
In addition, during the six months ended December 31, 2002, the Company settled
with Homestore.com, Inc. all issues pending related to amounts held in escrow in
connection with the sale. The Company paid $0.8 million from the escrow account
related to the settlement. The net cash provided by investing activities during
the six months ended December 31, 2001 includes the receipt of $46.0 million in
net proceeds from the sale of iPlace, Inc. in 2001. Capital expenditures were
$2.8 million during the six months ended December 31, 2002 and $3.0 million
during the six months ended December 31, 2001.
15
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Net cash used in financing activities was $14.0 million for the six months ended
December 31, 2002 versus $14.8 million for the six months ended December 31,
2001 primarily due to the repurchase of treasury stock. The Company purchased
873,000 shares of treasury stock in 2002 for $15.0 million, an average price of
$17.13, and 1,142,000 shares in 2001 for $15.7 million, an average price of
$13.72. During the quarter ended September 30, 2002, the Board of Directors
authorized an additional 2.5 million shares to be repurchased under the buyback
program. As of December 31, 2002, the Company had 2.1 million shares available
for repurchase under its buyback program.
As of December 31, 2002, the Company had cash and cash equivalents of $82.8
million. In addition, the Company has an $18 million bank credit facility which
bears interest at the higher of the base commercial lending rate for the bank or
the Federal Funds Rate plus 0.5% per annum. As of December 31, 2002, the
effective interest rate for borrowings was 6.16%. There were no borrowings
outstanding under this bank credit facility as of December 31, 2002. The bank
credit facility has certain financial covenants, including a maximum debt
coverage ratio, a minimum fixed charges coverage ratio, potential restrictions
on additional borrowings and potential restrictions on additional stock
repurchases. The Company believes that existing cash balances, cash generated
from its operations and its available bank credit facility, will be sufficient
to meet its funding requirements for at least the next twelve months.
The Company did not have any material commitments for capital expenditures as of
December 31, 2002. The Company intends to utilize cash generated from operations
to fulfill any capital expenditure requirements for the remainder of fiscal
2003.
COMMITMENTS
The Company is not aware of any factors that are reasonably likely to adversely
affect liquidity trends, other than the risk factors presented in the Forward
Looking Statements in this Form 10-Q filing. The Company does not have
off-balance sheet arrangements, non-exchange traded contracts or material
related party transactions.
Future minimum payments of contractual obligations as of December 31, 2002 are
as follows (amounts in thousands):
Payments Due by Period
-------------------------------------------------------------------------------
Less than
Total 1 year 1-3 years 4-5 years After 5 years
-------------- ------------- -------------- -------------- ---------------
Operating leases $ 27,645 $ 6,424 $ 11,135 $ 5,346 $ 4,740
Capital leases 33 33 - - -
Notes payable - - - - -
Other long-term obligations 262 235 27 - -
-------------- ------------- -------------- -------------- ---------------
Total payments due $ 27,940 $ 6,692 $ 11,162 $ 5,346 $ 4,740
============== ============= ============== ============== ===============
The Company operates in leased facilities. Management expects that leases
currently in effect will be renewed or replaced by other leases of a similar
nature and term.
16
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"), which is effective
for exit or disposal activities that are initiated after December 31, 2002. SFAS
146 requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan and nullifies Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (Including Certain Costs in a Restructuring)." MemberWorks
does not believe that the adoption of SFAS 146 will have a material impact on
the Company's financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires a guarantor to include
disclosure of certain obligations, and if applicable, at the inception of the
guarantee, recognize a liability for the fair value of other certain obligations
undertaken in issuing a guarantee. The recognition requirement is effective for
guarantees issued or modified after December 31, 2002. MemberWorks does not
believe that the adoption of FIN 45 will have a material impact on the Company's
financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123." This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, this Statement amends APB Opinion No. 28,
"Interim Financial Reporting," to require disclosure about those effects in
interim financial information. The transition provisions of this statement shall
be effective for financial statements with fiscal years ending after December
15, 2002. The disclosure provisions of this statement shall be effective for
financial reports containing condensed financial statements for interim periods
beginning after December 15, 2002. The Company has not yet completed its
analysis of the effects of adopting this statement on its consolidated financial
positions or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51 and applies immediately to any variable
interest entities created after January 31, 2003 and to variable interest
entities in which an interest is obtained after that date. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN 46
must be applied for the first interim or annual period beginning after June 15,
2003. While it will continue to evaluate the requirements of FIN 46, MemberWorks
does not believe that the adoption of FIN 46 will have a material impact on the
Company's financial statements.
17
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements that are
based on current expectations, estimates, forecasts and projections about the
industry in which MemberWorks operates and the Company's management's beliefs
and assumptions. These forward-looking statements include statements that do not
relate solely to historical or current facts and can be identified by the use of
words such as "believe," "expect," "estimate," "project," "continue" or
"anticipate." These forward-looking statements are made pursuant to safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance and are
based on a number of assumptions and estimates that are inherently subject to
significant risks and uncertainties, many of which are beyond our control,
cannot be foreseen and reflect future business decisions that are subject to
change. Therefore, actual outcomes and results may differ materially from what
is expressed or forecasted in such forward-looking statements. Among the many
factors that could cause actual results to differ materially from the
forward-looking statements are:
-- Higher than expected membership cancellations;
-- Lower than expected membership renewal rates;
-- Changes in the marketing techniques of credit card issuers;
-- Increases in the level of commission rates and other compensation
required by marketing partners to actively market with MemberWorks;
-- Potential reserve requirements by business partners such as the
Company's payment processors;
-- Unanticipated cancellation or termination of marketing agreements and
the extent to which MemberWorks can continue successful development
and marketing of new products and services;
-- Unanticipated changes in or termination of the Company's ability to
process membership fees through third parties, including clients,
payment processors and bank card associations;
-- The Company's ability to introduce new programs on a timely basis;
-- The Company's ability to develop and implement operational and
financial systems to manage growing operations;
-- The Company's ability to recover from a complete or partial system
failure or impairment, other hardware or software related malfunctions
or programming errors;
-- The Company's ability to obtain financing on acceptable terms to
finance the Company's growth strategy and to operate within the
limitations imposed by financing arrangements;
-- The Company's ability to integrate acquired businesses into the
Company's management and operations and operate successfully;
-- Further changes in the already competitive environment for the
Company's products or competitors' responses to the Company's
strategies;
-- Changes in the growth rate of the overall U.S. economy, or the
international economy where MemberWorks does business, such that
credit availability, interest rates, consumer spending and related
consumer debt are impacted;
-- Additional government regulations and changes to existing government
regulations of the Company's industry; and
-- New accounting pronouncements
Many of these factors are beyond MemberWorks' control, and, therefore, its
ability to generate predictable revenue and income growth may be adversely
affected by these factors.
MemberWorks cautions that such factors are not exclusive. All of the
forward-looking statements made in this Quarterly Report on Form 10-Q are
qualified by these cautionary statements and readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date of this Quarterly Report on Form 10-Q. Except as required by law,
MemberWorks does not have any intention or obligation to publicly update any
forward-looking statements, whether as a result of new information, future
events or otherwise.
18
MEMBERWORKS INCORPORATED
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate
The Company has an $18.0 million bank credit facility which bears interest at
the higher of the base commercial lending rate for the bank or the Federal Funds
Rate plus 0.5% per annum. There were no borrowings outstanding under this bank
credit facility as of December 31, 2002. Management believes that an increase in
the commercial lending rate or the Federal Funds rate would not be material to
the Company's financial position or its results of operations. If the Company is
not able to renew its existing credit facility agreement, which matures on April
1, 2003, it is possible that any replacement lending facility obtained by the
Company may be more sensitive to interest rate changes. The Company does not
currently hedge interest rates.
Foreign Currency
The Company has international sales and facilities in Canada and therefore, is
subject to foreign currency rate exposure. Canadian sales have been denominated
in the Canadian dollar and its functional currency is the local currency. Assets
and liabilities of the Canadian subsidiary are translated into U.S. dollars at
the exchange rate in effect as of the balance sheet date. Income and expense
items are translated at the average exchange rate for the period. Accumulated
net translation adjustments are recorded in shareholders' equity. Foreign
exchange transaction gains and losses are included in the results of operations,
and were not material for all periods presented. As a result, the Company's
financial results could be affected by factors such as changes in foreign
currency exchange rates or weak economic condition. To the extent the Company
incurs expenses that are based on locally denominated sales volume paid in local
currency, the exposure to foreign exchange risk is reduced. The Company has
determined that the impact of a near-term 10% appreciation or depreciation of
the U.S. dollar would have an insignificant effect on its financial position,
results of operations and cash flows. The Company does not maintain any
derivative instruments to mitigate the exposure to translation and transaction
risk. However, this does not preclude the Company's adoption of specific hedging
strategies in the future. MemberWorks will assess the need to utilize financial
instruments to hedge currency exposures on an ongoing basis.
Fair Value
The Company does not have material exposure to market risk with respect to
investments, as the Company does not hold any marketable securities as of
December 31, 2002. MemberWorks does not use derivative financial instruments for
speculative or trading purposes. However, this does not preclude the Company's
adoption of specific hedging strategies in the future.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures.
The chief executive officer and chief financial officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined in
the Securities Exchange Act of 1934 Rules 13a-14(c) and 15-d-14(c)) as of a date
within 90 days of the filing of this quarterly report (the "Evaluation Date")
and have concluded that as of the Evaluation Date, the Company's disclosure
controls and procedures were effective. The Company's disclosure controls and
procedures are designed to ensure that material information relating to
MemberWorks and its consolidated subsidiaries that are required to be disclosed
in its reports under the Exchange Act is accumulated and communicated to the
chief executive officer and chief financial officer.
Changes in internal controls.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect our controls subsequent to the
Evaluation Date.
19
MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Except as set forth below, in management's opinion, there are no significant
legal proceedings to which the Company or any of its subsidiaries is a party or
to which any of their properties are subject. The Company is involved in other
lawsuits and claims generally incidental to its business including, but not
limited to, various suits, including suits previously disclosed in the 2002
Annual Report filed on Form 10-K , brought against the Company by individual
consumers seeking monetary and/or injunctive relief relating to the marketing of
the Company's programs. In addition, from time to time, and in the regular
course of its business, the Company receives inquiries from various federal
and/or state regulatory authorities. Management does not believe that there will
be any material effect on the results of operations as a result of its
outstanding litigation proceedings.
In March 2002, the Company and other plaintiffs filed suit against
Homestore.com, Inc. in United States District Court for the District of
Connecticut. The action was transferred to the United States District Court for
the Central District of California. The suit, which sought injunctive and other
relief, alleged securities fraud, negligent misrepresentation, breach of
contract and other grounds in connection with the Company's sale of its interest
in iPlace, Inc. In response to plaintiffs' preliminary motions, the court
ordered Homestore.com, Inc. to place $58.0 million in a constructive trust
pending resolution of the lawsuit or further order of the court. During the
quarter ended September 30, 2002, MemberWorks, along with certain of the other
former shareholders of iPlace, Inc., settled their lawsuit against
Homestore.com, Inc. The total settlement amount in favor of the plaintiffs was
$23.0 million, of which MemberWorks received $19.1 million.
On January 24, 2003, the Company filed a motion with the Superior Court for the
Judicial District of Hartford, Connecticut to vacate and oppose the confirmation
of an arbitration award issued in December 2002. The arbitration, filed against
the Company by MedValUSA Health Programs, Inc. ("MedVal") in September 2000,
involved claims of breach of contract, breach of the duty of good faith and fair
dealing, and violation of the Connecticut Unfair Trade Practices Act ("CUTPA").
Even though the arbitrators found that MemberWorks was not liable to MedVal for
any compensatory damages, they awarded $5.5 million in punitive damages and
costs against MemberWorks solely under CUTPA. MemberWorks believes that this
arbitration award is unjustified and not based on any existing legal precedent.
Specifically, the Company is challenging the award on a number of grounds,
including that it violates a well defined public policy against excessive
punitive damage awards, raises constitutional issues and disregards certain
legal requirements for a valid award under CUTPA. The hearing on the Company's
motion was held on February 10, 2003. However, the date that the judge will rule
on the motion is unknown. While the Company intends to vigorously seek to vacate
this award, as well as to take action to prevent the enforcement of the award
by, among other things, seeking to prevent the confirmation of the award, there
can be no assurance that MemberWorks will be successful in its efforts. The
Company has made no provision in its financial statements for this contingency
because it believes that a loss is not probable.
20
MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
a) MemberWorks Incorporated's 2002 Annual Meeting of Stockholders was held on
November 21, 2002.
b) At the annual meeting the following Class III Directors were elected to the
Board of Directors as follows:
Gary A. Johnson: For - 10,187,494
Against - 1,537,987
Abstain - 0
Nonvotes - 0
Robert Kamerschen: For - 11,415,592
Against - 309,889
Abstain - 0
Nonvotes - 0
Class I Directors, Alec L. Ellison and Marc S. Tesler, and Class II
Directors, Scott N. Flanders, Michael T. McClorey and Edward M. Stern,
continue to serve as Directors of the Company.
c) The ratification of PricewaterhouseCoopers LLP as the Company's independent
auditors was also approved at the annual meeting as follows:
For - 11,288,501
Against - 435,870
Abstain - 1,110
Nonvotes - 0
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
None.
b) Reports on Form 8-K
On December 23, 2002, the Company filed on Form 8-K under Item 5 "Other
Events" and Item 7 "Financial Statements and Exhibits" a Press Release
announcing the completion of a marketing agreement with America Online, Inc.
21
MEMBERWORKS INCORPORATED
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEMBERWORKS INCORPORATED
(Registrant)
Date: February 14, 2003 By: /s/ Gary A. Johnson
---------------------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
February 14, 2003 By: /s/ James B. Duffy
-----------------------------------
James B. Duffy, Executive Vice President and
Chief Financial Officer (Principal Financial
and Accounting Officer)
22
CERTIFICATIONS
I, Gary A. Johnson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MemberWorks
Incorporated,
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: February 14, 2003 By: /s/ Gary A. Johnson
---------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
23
CERTIFICATIONS (CONTINUED)
I, James B. Duffy, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MemberWorks
Incorporated,
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: February 14, 2003 By: /s/ James B. Duffy
-----------------------------------
James B. Duffy, Executive Vice President and
Chief Financial Officer (Principal Financial
and Accounting Officer)
24